Contracts as Reference Points - Experimental Evidence

Ernst Fehr, Oliver D. Hart and Christian Zehnder

No 14501, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In a recent paper, Hart and Moore (2008) introduce new behavioral assumptions that can explain long-term contracts and important aspects of the employment relation. However, so far there exists no direct evidence that supports these assumptions and, in particular, Hart and Moore's notion that contracts provide reference points. In this paper, we examine experimentally the behavioral forces stipulated in their theory. The evidence confirms the model's prediction that there is a tradeoff between rigidity and flexibility in a trading environment with incomplete contracts and ex ante uncertainty about the state of nature. Flexible contracts - which would dominate rigid contracts under standard assumptions - cause a significant amount of shading on ex post performance, while under rigid contracts, much less shading occurs. Thus, although rigid contracts rule out trading in some states of the world, parties frequently implement them. While our results are broadly consistent with established behavioral concepts, they cannot easily be explained by existing theories. The experiment appears to reveal a new behavioral force: ex ante competition legitimizes the terms of a contract, and aggrievement and shading occur mainly about outcomes within the contract.

JEL-codes: C9 D0 K0 (search for similar items in EconPapers)
Date: 2008-11
New Economics Papers: this item is included in nep-cta, nep-exp and nep-law
Note: CF LE
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (276)

Published as Ernst Fehr & Oliver Hart & Christian Zehnder, 2009. "Contracts, Reference Points, and Competition-Behavioral Effects of The Fundamental Transformation," Journal of the European Economic Association, MIT Press, vol. 7(2-3), pages 561-572, 04-05.
Published as Ernst Fehr & Oliver Hart & Christian Zehnder, 2011. "Contracts as Reference Points--Experimental Evidence," American Economic Review, American Economic Association, vol. 101(2), pages 493-525, April.

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Related works:
Journal Article: Contracts as Reference Points--Experimental Evidence (2011)
Working Paper: Contracts as Reference Points: Experimental Evidence (2008)
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